YouTube will generate about $200 million of revenue this year,* say two WSJ sources, short of Google’s expectations. Chief salesman Tim Armstrong is trying to overhaul YouTube’s overly complicated (and expensive) sales process, but the company is now considering much more drastic measures. WSJ:

Google plans to begin accepting “preroll” and “postroll” ads, which will run before and after some YouTube video clips, according to one person familiar with the matter. The plan under consideration, this person says, would give companies that post video clips the option to sell such ads, and share the revenue with Google. YouTube has long forsworn such ads because consumers don’t like them. But advertisers consider them highly effective.

This is a big deal: Google’s intense dislike of preroll is both aesthetic (they’re a clumsy “old media” ad strategy, and Google doesn’t like to think of itself that way) and practical (we’re told that Google has found that 80% to 90% of video-watchers flee the instant they see one of the ads). So resorting to pre-rolls – after Eric Schmidt had promised that YouTube had awesome new ad schemes in the works – is an admission that the Mountain View brain trust is stumped.

Of course, one other obvious solution to YouTube’s sales woes would be to simply start advertising on YouTube pages, period. Nearly any page you see on the site today is ad-free. But Google is showing a billion clips a day. Why not simply start loading some of those pages with AdSense units?

Because of the other big admission in the WSJ story – Google is afraid to sell ads on 96% of its inventory:

Fearful of fueling allegations that it is profiting from copyright infringement, Google will only sell ads against YouTube clips that have been posted or approved by media companies and other partners – roughly 4% of the total, says one person familiar with the matter.

The story ascribes Google’s fears to the billion-dollar Viacom suit, but we think that’s not fair: Even if Philippe Dauman ends up settling with Google, it’s not going to resolve the copyright cloud hovering over YouTube. So either Google’s going to need a legal ruling that gives it the go-ahead to make money on its copyright-violating inventory – or it’s going to have live with diminished expectations for its $1.65 billion business.

Congrats to Forbes for pegging the $200 million number earlier this year.

See Also: Eric Schmidt: Google Has Secret Plan To Mint Money With YouTube